Billions With Zero Knowledge

I’ve been watching the new CBC show Dragon’s Den, and I’m concerned by the examples being set for any entrepreneurs watching or participating.

Anyone who thinks this show has anything to do with real business angel investing is probably smoking the same stuff as Peter, Paul and Mary.

Now, for those who haven’t seen the show, the basics are that entrepeneurs pitch five wealthy business angels for investments (with the angels cast as Dragon’s protecting their money from entrepreneurs with bad ideas and dolling it out to promising startups).

The Dragon’s then make an offer for an amount of money & share of the company or send the entrepreneur packing. From an entertainment point of view, it’s a fun show. I enjoy the American Idol - William Hung factor of watching some really bad business pitches as much as the next persion.

I’m also of the strong opinion that anything that helps promote an entrepreneurial spirit in Canada is much needed and welcome.

That being said, there is a lot about raising money from angel investors that isn’t well suited to the format of an entertainment show. Aspiring entrepreneurs might be confused about what lessons to take away from the show.

This weeks episode where Toronto based Jobloft gave up a 50% of their company for a $200k investment was the turning point for me. The company flat out got bad advice somewhere along the way and as a result were mauled by the dragons.

Sean writes that all contestants were coached by either his firm Wise Mentor Capital or Pierre-Luc at Ignite Partners. After what I’ve seen on the first three episodes I really question the quality of the advice they are getting.

Now, if you have seen the contestants so far it is obvious that a number of the contestants have been selected for the entertainement value associated with crazy pitches. I don’t have a problem with this. There are crazy pitches in real life, and showing the audience some of these crazy ideas getting shot down provides the drama. Sean makes a good point when he posts the following on the selection process,

First, this is a show about what works when it comes to pitching for capital. It is meant to highlight what’s out there in the real world and meant to share lessons that can be learned, from the good and from the bad. You can learn from those that fail as much, if not more than from those that succeed. Further, as in the case of Jason C, the show has helped him put his venture to rest and move on to better things. It isn’t just those who get money that become winners, some win from the experience. Plus just like in the real world, you have a signal to noise ratio (how much crap you need to see to find a good “signal” aka deal). I’ve been screening deals since 1999, have seen 2000+ deals to date (not including the show) and let me tell you, there are people like our pitchers in the real world too.

and

Finally, we didn’t pick just winners to put on, because a) there would be no drama in that and b) we can only work with those that apply. If we get a season two (do you guys want one?) then all those who think they can do better, are welcome to apply.

Letting dog deals pitch is fine. Not advising them properly is uncool. My basis for this assumption is based on two pet peeves with the shows so far.

Costumes and Attire

Every single candidate should have been advised on wearing business attire. I’m not talking a casual suggestion (someone must have mentioned something), they should have been told not to bother pitching if they weren’t dressed in proper business attire. With Amber’s bikini, David’s umpire outfit and Jason’s white running shoes already standing out as examples of inappropriate attire I was frustrated to see the previews for upcoming episodes full of more examples of gimic costumes and stupid outfits.

I’ve always been one of the most casually dressed at all my companies. Most days I can be found at the office, unshaven wearing a Kangol hat and jeans. But when I am representing my company asking for money from people I don’t know - I’m dressed appropriately. (On the east coast this is a suit and dress shirt, I don’t usually wear a tie unless it is a very formal meeting. In silicon valley business casual (khaki’s and sport coat) works fine).

There are a number of psychological reasons proper business attire helps you establish rapport with investors. Many pitches are dead on arrival simply because you present yourself in a manner that creates negative rapport before you’ve opened your mouth. Good rapport is critical to creating great pitches.

Dragon Jennifer Wood was dead on with her comments to Amber about her attire and using human models if you your pitch includes a gimic (gadget, sex, flying pigs etc.) - not being the gimic yourself.

If candidates without the experience to know this basic rule are volunteering to pitch then I consider it the job of the advisors to lay down the law and help them have the best chance in the dragons den. Amber’s inability to present a coherent business proposition would have doomed her pitch anyway - but she should have been presentable while she was being turned down - not the tagline of some boardroom joke.

Polygamous Shotgun Weddings

Now this is more a problem with the format of the show then with the advisors. It is completely flawed and designed against everyones interest except the shows producers (who benefit from the tense negotiation drama & entertainment value of rushed decisions).

Taking money from an investor is like getting married. You are going to be sharing the same bed (your company) for many years.

Would you get married and give half your assets to someone you’ve known for five minutes, an hour? Now contemplate this - would you marry into a polygamous marriage with 5 co-wifes/co-husbands after an hour long meeting?

The team from Jobloft had this to say about getting all 5 dragons as investors

The $200,000 will be a definite asset to the company, but the most important part is the intangible value that each dragon brings to the company.
We’ve watched the old BBC shows of Dragons’ Den in the past, and it’s usually 1-2 dragons who invest in a company. But to have ALL 5 Dragons believing in your company is truly something else.

To have the founder of La Senza, Boston Pizza and Mr. Lube on our side is truly priceless. Here are two successful gentlemen who understand the pain in recruitment and know our industry like the back of their hands. Not only did we get support from Retail & Food services gurus but, the other dragons understand technology & marketing and are gurus in their own respect.

The power of network, experience and business acumen is worth its weight in gold, far surpassing any monetary value. Not many 23-24 year olds out of university can say that their partners are Laurence Lewin, Robert Herjavec, Kevin O’Leary, Jim Treliving and Jennifer Wood in one sentence.

In a rushed environment, with prominent and well connected business angels hovering over you with money it may seem like getting 5 famous angels is a good thing. Often times it is not.

Given that the shows format leaves the Jobloft team without the chance to spend any quality time to get to know their investors as people (not their biographies - what kind of partners & people are they?) they may have just made a faustian bargin.

You now have 5 strong willed, independent, opiniated experts who each have a different understanding or vision of what your company, product and growth opportunities are. (They must have different visions since they’ve known your company for less then an hour.)

What happens when they don’t agree? What happens when they are wrong - will they listen to you?

What are their different management styles as investors and board members? Have you just created 5 different reporting structures?

What happens when you need to raise more money and they all disagree on the strategy or valuation? Does your shareholder agreement allow you to drag along investors who don’t sign onto the new financing plan?

These are just a few of the questions that need to be discussed before accepting any investment offer. I’ve had rich and famous investors in my companies who have added great value. I’ve had others who threatened to fund competitors or withhold signatures on key documents unless I agreed to enter into shady side deals. Both came with successful pedigrees but in the later case, the person was simply an asshole and we got him away from the company as soon as possible.

Now the Jobloft guys are not completely wrong. They have a great team of angels - who I suspect are smart enough to assign only one or two board members who will act as the ‘managing partner’ for the deal reducing the amount of herding required to get all the angels singing the same song - but what if this doesn’t occur?

I once made an angel investment in a friends company where other investors and board members highjacked the deal and distracted management for a good year. The company was forced to raise more money and the founders share has been dramatically reduced. No one had the power to help or assist because there were too many people in the deal with competing interests.

This is also a bad idea for the dragons. Angel investors shouldn’t be operating companies - their job is to support the team that is. These investors have other companies and investments to nurture. While angels can help - they will not do all the heavy lifting. They need management teams that will carry the majority of the load.

The dragons don’t have the time in this format to really assess the team, their plans and what is best for the company. The dragons are making snap decisions on investments, which I suspect is one of the reasons they are insisting on large stakes in the company. Should anything go wrong, they can step in and restart the company as long as they have enough equity. This is a bad situation from the start, the dragons and entrepreneurs interests are not aligned.

[I'm happy to be corrected by anyone involved in the show. If there long discussions between Dragon's and entrepreneurs that have been edited out - please let me know about it.]

Some of the other items that should be discussed before anyone talks about term sheets or offers are,

1. What are the capital requirements of the business as it grows ?
2. how far the funds are going to take the company ?
3. which milestones are the critical ones to get the company to the next risk reduction phase ?
4. what kind of shareholder agreement will be required ?
5. what is the strategy for future financings ?
6. how large should the employee option pool be ?
7. what preferred rights if any do the dragons have ?
8. what will the management team look like as you grow ?

these are just a few simple examples of what both the dragons and startups should be discussing to determine if there is a common fit (I could add sales & pricing strategies, technology investments, product direction and hiring philosophy to the lists of discussions as well)

There should be a minimum of 3 days in which the entrepreneurs and dragons develop a shared plan for the company. This plan needs to include all the key elements of an operating plan, with major milestones, pro-forma financial projections, sales strategies, technology roadmap and hiring plans.

Ideally the format of the show would be to have the dragons make an offer, and give contestants a week to negotiate terms, get to know the dragons, allow the dragons to perform due diligence to understand the business and see if both parties can come to terms with an agreement that aligns their interests.

I won’t go into any length on how this could be done while maintaining the shows entertainment value - but if American Idol can have a separate results show they can figure out how to split the format between the offer and the acceptance of investments.

[I personally think it would be great television to view selected parts of the term sheet negotiations and due diligence. It would be entertaining to see if the entrepreneurs were able to get a better deal after a week of negotiations & due diligence or if the deal would fall apart.]

My complaint about business attire may seem insignificant, but if contestants aren’t getting good advice on this basic rule of pitching then what other advice is being sacrificed for the sake of good television?

Given the format of the show, every presenting company should be adequately prepared to discuss investment terms that align the both parties interests.

IMHO - Serious deals should be pitched as convertible debt since this is a structure that allows valuations, terms/conditions to be deferred until everyone has a better understanding of the companies prospects (Usually this is when the company raises the next round which can trigger the conversion at a discounted rate to that valuation).

There is a reason why most angels deals in the valley are structured this way. It works and is a structure that helps align everyones interests. It’s not perfect, but is well suited for companies at this stage.

I won’t go into all the reasons I prefer convertible debt as a structure for angel investments, but my main point is that any entrepreneur raising money needs to get advisors that understand these issues who can give you candid advice not associated with a show. The advisors should be telling this to entrepreneurs, but it would ruin the show to tell entrepreneurs not to rush to accept anyone’s money until they’ve spent enough time with them to be 100% sure you all agree with how the money will be used to help the company grow.
Canada needs more mentors for entrepreneurs and more examples of stayed-at-home Canadian success stories. I wouldn’t advise any serious entrepreneurs to pursue this financing option unless the format of the show changes. For entrepreneurs who don’t mind the idea of a shotgun plural marriage then at least they should have professional advisors on hand to help them make an informed snap decision (Lawyers or better experienced entrepreneurs who have raised venture capital and angel money -  but since most professional advisors will tell entrepreneurs not to rush to accept a deal this would be anti-climatic for the show).

The show has a lot of promise and I hope the producers are able to tweak the format. It would be a better show, and a great example to entrepreneurs on how real angel investments are done.

Entrepreneur heal thyself

Advice after injury is like medicine after death

Ancient Proverb

Despite my hesitations regarding the show, I really want to congratulate the entire team at Jobloft on their great pitch and your new investors. You guys did a great job and have my best wishes for your success.

With a few companies under my belt and a fair amount of fundraising experience it is easy to wax poetic with unsolicited advice about fundraising. You guys shouldn’t care what people like me say - except as a learning experience for your next fundraising round.

When I was 21, I raised my first angel investment for my Internet provider. I raised $70,000 from two investors, my father and an independent angel he forced me to find before he would cough up his love money (Love Money is the most popular source of financing for entrepreneurs. It is money raised from those who love you.). I gave up 66% of the company for that money and have never regretted a single day since.

We eventually sold that company and made my first big win, which allowed me to finance my second startup Zero-Knowledge Systems.

The best cure for a deal that you may have second thoughts about is success. I didn’t care about what share I eventually owned of Total.net when we sold it. I was just ecstatic that we had made it across the finish line and sold the business successfully at a time when most other large Canadian ISPs were going bankrupt.

Make the best of your deal, by enjoying your ride. Find a great mentor (independent from your new angel partners) as you start to plan your next financing round. If you are succeeding in executing on your plan with new investors willing to fund your next stage of growth, there are lots of structures to improve on your deal as you progress. Just make sure you have your own mentors to get some good advice from.

So congratulations Jobloft - you got a much better deal - with stronger angels then I ever did at your ages. I can’t wait to see what you’ll be doing in 5 years.

On Tue 24 Oct 2006.